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Toyota's Midlife Crisis

December 20, 1998

International Business: JAPAN

TOYOTA'S MIDLIFE CRISIS

Can it appeal to young Japanese buyers?

Toyota Motor Corp.'s commander in chief, Hiroshi Okuda, is beaming. Hundreds of French citizens are gathered to celebrate his latest conquest: a sprawling site for a $727 million factory near Valenciennes, in northeastern France. Okuda seals the deal by laying two stones for the plant, contributing $177,000 to local causes, and planting several cherry trees--proof that Toyota wants to take root in Europe. Then he dons a short kimono and takes up a wooden mallet to open four barrels of hot sake as part of Japanese ritual. The spectacle leaves little doubt that Okuda is serious about extending Toyota's reach around the world.

But back at home, Toyota looks battered. Japan's No. 1 carmaker managed record pretax operating profits of $3.4 billion, on sales of $52 billion, for the first half of this year. Yet these figures obscure something important: Toyota is barely breaking even in its most critical market, Japan.

Some analysts believe the company has started to lose money in its domestic car business. Merrill Lynch & Co. reckons Toyota loses $423 on every car it sells at home. Only the sale of spare parts and accessories pushes domestic operations into the black. Toyota slices the data differently: It lumps export profits from Japanese plants together with domestic sales. But even executives admit conditions in the home market are dreadful. Toyota's vehicle sales in Japan have tumbled 31% since 1990. Its market share has been below 40% since 1995, and the company must spend more than ever to lure customers into showrooms. Japan's economy, it seems, has become Toyota's Achilles' heel.SHORT ON ZIP. To Toyota's North American rivals, none of this matters for now. All they see is the Toyota juggernaut in the U.S., which in November upped its share of the world's biggest market by more than a full percentage point, to 9.1%. Detroit executives are only dimly aware of Toyota's woes at home. They probably figure the giant will recover its momentum when the recession ends. "Toyota is a tough, tough competitor," says Ronald L. Zarrella, head of General Motors' North American division.

But the question still demands an answer: How long can any carmaker afford to give up profits in its core market? Japan accounts for just 38% of Toyota's worldwide car sales--down from 52% in 1990. Those sales generate little in the way of profit, while North America accounts for an estimated 80% of operating income, with Europe accounting for most of the rest. "Americans have been feeding us," concedes Kanji Kurioka, executive vice-president for domestic sales. Yet with the yen now strengthening against the dollar, every one-yen increase knocks some $68 million off net profit. Says Fujio Cho, executive vice-president for corporate planning: "I tell people, `You can't rely forever on a weaker yen."'

The recession has certainly taken a bite out of Toyota's Japanese results, but the company must accept much of the blame for its troubles. It has failed to cater to younger buyers' desires for zippy compact minivans and sport-utility vehicles. And shrinking sales mean that Toyota must pay for factory and dealership workers it doesn't need.

Toyota's woes typify the problems plaguing Japan Inc. Until the mid-1990s, Toyota could depend on results at home to drive rapid expansion abroad: Some analysts believe Toyota earned as much as 90% of operating income from its domestic operations at its peak in 1990. The Japanese market was predictable, with Toyota on top. It faced weak rivals, was supported by dealers who felt little need to discount, and sold to consumers who meekly accepted high prices.

Now, the pattern is reversed, and overseas profits are propping up Japan. Excess capacity, picky consumers, surplus workers, price wars, and hemorrhaging affiliates have become the rule in Japan. Honda Motor Co., which for years played a small role in Japan, is attacking Toyota's domestic market with a vengeance. Already, Toyota must worry about keeping its No. 3 ranking among the world's auto makers. DRI/McGraw-Hill automotive analyst Philip Rosengarten estimates that Toyota and Volkswagen will each sell 4.5 million vehicles this year.

If these conditions persist, even Toyota's $25 billion cash hoard could dwindle, as the giant wages a war of attrition at home. Eventually, a low-profit domestic market could undermine its global ambitions. "In a sense, we are troubled," admits Okuda. "We set a target of selling 6 million vehicles [a year] by the early 21st century. However, because of the recession, it's necessary to extend that target."

Some Toyota executives compare their problems to those GM faced more than a decade ago. "Sometimes, we face difficulties deciding which direction to go," says Chairman Shoichiro Toyoda. "I used to think that [GM Chairman] Roger Smith had [that] trouble." Toyota is much healthier than GM--but Toyota executives know how foreign profits dulled GM management's sense of crisis. GM's U.S. market share has shrunk from 40.3% in 1985 to 29.4% this year.SACRED GROUND. So Okuda has embarked on an aggressive restructuring. "Toyota has a sense of crisis. It is making efforts, but it takes time," says Takaki Nakanishi, an analyst at Merrill Lynch. Yet watching rivals such as Nissan Motor Co. and Mitsubishi Corp. approach the brink has convinced Okuda that the longer he waits, the more painful the process will be.

The workforce is one place to start restructuring. Next year, Toyota will hire 9% fewer high school and university graduates. Some of these new hires will be contract employees with no expectation of lifetime employment. If all goes as scheduled, such hires will make up one-third of the payroll by early in the next century. "We will be gradually reducing our workforce," says Okuda.

Toyota also expects to shed $678 million in costs this year, largely by designing cars with fewer, simpler parts and sharing more parts between models. To shave an estimated 30% off development costs, Toyota is using the chassis from its European-designed Yaris for a new subcompact in Japan and for at least two other models. Such efforts should lessen the blow of smaller sales volumes during Japan's deepening recession. Toyota's engineers used to develop cars on the assumption that the company would sell 10,000 units per month. Now, many must design cars to make profits at lower prices and monthly volumes as low as 2,500.

Beyond that, Okuda is shaking up the chain of command to regain its market share among Japan's younger buyers. After he became president in 1995, Okuda ordered a task force of Toyota's thirtysomething managers to make up a youth division and to think big--fast. "He said that if we couldn't think of anything in three months, then we probably wouldn't be able to come up with an idea," recalls Hideaki Homma, 35. The result was a new company to design and sell cars for young people. Dubbed the Virtual Venture Co. (VVC), its managers answer only to Okuda and work in the hip Tokyo district of Sangenjaya, well-removed from Toyota's stodgy headquarters.

VVC is scheduled to develop at least one cool car by 2000. But the longer VVC takes, the more opportunities Toyota will miss to lure those crucial younger buyers. "Toyota is for old people, not for us," says Ken Nomura, 29, who cruises around Tokyo with his girlfriend in a Honda $19,200 CR-V sport-utility vehicle.

In the meantime, the VVC subsidiary is experimenting with unconventional sales strategies. For a small fee, it is allowing the public to test-drive most of the cars in Toyota's lineup in a Kobe parking lot. It's building an $83 million amusement park on the edge of Tokyo that will open in April, complete with everything from futuristic vehicles to an area where people can design their own cars. VVC estimates these efforts have boosted sales of some Toyota models by 10%.A FEW FLOPS. Good stuff, but Toyota continues to struggle to regain its 40% market share. Many of Toyota's attempts to create entirely new markets aren't working. The Altezza and Progres luxury cars are hits. But the $18,600 Vista next-generation sedan and the $16,000 Nadia "monospace" sedan, which looks like a cross between a station wagon and a minivan, continue to fall far short of sales targets.

Even Toyota's revolutionary hybrid, the Prius--which runs both on gasoline and an electric battery to cut the emissions dramatically--may be an example of a superb technology with no real market. The $16,500 Prius is being sold at a price that analysts estimate is only about half what it costs to build the car. Toyota makes 2,000 Prius cars a month, yet consumers have lately been buying less than 1,600 every month. "The Prius is being sold near [other Toyotas] that are discounted. And only cheap cars are selling now," says a disappointed Akihiro Wada, executive vice-president for research and development.

To plump up sales of the Prius and other models, Toyota is overhauling its 5,600 dealership outlets. It has stopped supplying dealers with look-alike models, to eliminate unnecessary price competition, and starting next year, if dealers cannot meet sales targets, they run the risk of losing their franchise. Sixty-six dealers have established 1,074 "Netz" outlets intended to attract women and youth with showrooms that are brighter and swankier than most Toyota outlets. On its own, Toyota has begun constructing a massive "auto mall" in the Japanese Alps that will sell every model in Toyota's lineup--in addition to prefabricated houses.

Okuda figures that quite a lot more remains to be done, even while shrugging off the naysayers. "Analysts are saying all sorts of things about our company," he says. "They don't know anything about the future, and they don't know the details of our operations. I don't care that much about what they're saying." Nevertheless, he admits Toyota must go ahead at full speed. Says Okuda: "Recession is a time to overwhelm the enemy." And, he hopes, the best time to fix what ails Japan's preeminent company.By Emily Thornton in Tokyo, with Kathleen Kerwin in Detroit and Inka Resch in ValenciennesReturn to top